What is an Inverted Yield Curve
and Why is it Bad?
If you have been watching or listening to any news over the last week of May 2019 you probably have heard the term " Inverted Yield curve". This article provides a brief explaination of what a yield curve is and what it has historically meant to the markets.
One of the most closely watched predictors of a potential recession just yelped even louder.
The signal lies within the bond market, where investors show how confident they are about the economy by their level of demand for U.S. government bonds.
It's called the "yield curve," and a significant part of it flipped Friday for the first time since before the Great Recession: A Treasury bill that matures in three months is yielding 2.45 percent – 0.02 percentage points more than the yield on a Treasury that matures in 10 years.
It seems illogical. Economists call it an "inverted" yield curve. Normally, short-term debt yields less than a long-term debt that requires investors to tie up their money for a prolonged period. When a short-term debt pays more than a long-term debt, the yield curve has inverted.
And when the yield curve is inverted, it shows that investors are losing confidence in the economy's prospects.
This warning signal has a fairly accurate track record. A rule of thumb is that when the 10-month Treasury yield falls below the three-month yield, a recession may hit in about a year. Such an inversion has preceded each of the last seven recessions, according to the Federal Reserve Bank of Cleveland.
The last time a three-month Treasury yielded less than a 10-year Treasury was in late 2006 and early 2007, before the Great Recession made landfall in December 2007.
It must be remembered that the past is no prediction of the future only an insight.
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Three major risks loom for Canadian economy in 2019, says report
The Canadian economy is expected to grow about 2% -- roughly in line with central bank estimates, but several risks loom, says the 2019 Global Market Outlook from Russell Investments.
The report cautions that the threat of “triple C” – consumption, crude oil and competitiveness – will be critical in shaping the outlook for 2019 and beyond.
On the first point, about 60% of Canadian economic output is attributed to personal consumption, which is highly correlated to housing trends which are slowing.
Secondly, the report says the price of Canadian Western Canada Select (WCS) crude oil has become increasingly volatile because of problems dealing with building domestic pipelines. “A healthy energy sector is not only critical for business investment, but also exports, as energy products account for nearly 20% of total Canadian exports,” states the report. Both consumption and crude oil prices are expected to have an almost immediate impact on growth prospects for next year.
Canada less competitive than major trading partners
In addition, Canada has become less competitive than its American and Mexican counterparts. The federal government recently announced that it aims to address this issue through tax breaks for businesses and other measures, but the report calls this “merely a start.”
Among other Russell Investments forecasts:
Elsewhere in the world, the report predicts volatility will continue into 2019 given U.S. Federal Reserve tightening, trade wars, China uncertainty, Italy’s budget standoff with the European Commission and Brexit.
Russell Investments believes that 2020 marks the danger zone for a U.S. recession, which gives equity markets some upside in the year ahead. “However, late-cycle risks are rising—and monitoring these risks will be critical to avoid buying a dip that turns into a prolonged slide.”
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